Since hitting a low of 851p in January of last year shares of oil pump engineer Weir (LSE: WEIR) have rocketed over 125% in value to stand at 1,986p today. But does this record rally still have room to run?
Unfortunately, interim results released this morning cast doubt on the sustainability of this rally. While management remained confident it would hit analyst expectations for full year profits the market has already priced in a solid rebound in profits after a dismal 2016.
At today’s share prices the stock trades at a full 24.8 times forward earnings, so simply meeting market expectations is very unlikely to drive the stock much higher. Indeed, in early trading the stock is down by around 3% as analysts digest the results.
While Weir’s stock may not be able to double again in the next year unless oil & gas prices skyrocket the company is slowly making progress. A pickup in shale drilling in America led to a 50% year-on-year rise in oil & gas orders, although this was against a relatively weak comparative period. Yet, although frackers may be putting drills back into service as oil prices stabilise at around $50 they’re evidently still pressuring suppliers for price cuts because Weir’s management warned “pricing in this market remained at low levels.”
The ill effects of low pricing in upstream markets was compounded by continued poor trading in the firm’s downstream-oriented divisions. While this is cyclical and will work itself out eventually we don’t know when that will be.
In the meantime Weir is saddled with net debt that was £835m at the end of December and now higher at interim results, although management declined to give a concrete figure. Considering operations only kicked off £239m in cash flow last year this is a worryingly high amount. With debt high, little pricing power, no signs of oil breaking out of its $50/bbl level and a very lofty valuation I wouldn’t bet on Weir’s share price doubling again any time soon.
Stability in a turbulent industry
It’s a similar story for oil services firm Petrofac (LSE: PFC). The company’s share price has been much more stable during the period but it is also unlikely to see rapid appreciation unless oil prices move higher.
Yet this doesn’t mean the stock isn’t worth looking at. Due to its client base that is predominantly made up of Middle Eastern national oil companies Petrofac has kept revenue stable during the downturn even as oil producers have been hit hard.
In 2016 the company increased revenue 15% year-on-year and more than doubled EBITDA to $704m as it slashed staffing costs and broke ties with low margin contracts. This led to earnings rising to 93.29c, which was enough to once again cover the unchanged 65.8c dividend. At current prices this equals a whopping 6.08% yield that is well-covered by growing earnings.
Furthermore, the company’s backlog during the period rose a full 31% as its customers continued to award it contracts for both upstream and downstream projects. With net debt a very low $617m, or less than 1x EBITDA, a bumper dividend and cheap valuation of 9.5 times forward earnings Petrofac is one stock I wouldn’t mind holding even if oil prices remain subdued.
But if you’re looking for a cheap stock in a less cyclical industry than oil & gas you need look no further than the Motley Fool’s Top Small Cap, which is trading at just 8 times earnings. Besides a bargain valuation this company also has growth potential as it has increased earnings by double-digits each of the past four years.
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Ian Pierce has no position in any shares mentioned. The Motley Fool UK owns shares of and has recommended Petrofac. The Motley Fool UK has recommended Weir. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.